The Week in Public Finance: Scary Pensions and Puerto Rico's Red Alert

A roundup of money (and other) news governments can use.

New scary pension reporting rules not so scary?

A new report from the Center for State and Local Government Excellence said the upcoming accounting standards changes for reporting pension plan liabilities might not be the big bombshell that some folks previously thought. Many have said that the required changes, which call for a lower assumed rate of return in certain cases, could result in many plans’ unfunded liabilities appearing to balloon in a single year. But the report’s authors, Boston College’s Alicia H. Munnell, Jean-Pierre Aubry, and Mark Carafelli, noted that the proposed new calculation is based on a number of assumptions, including future contributions from the government and from employees. How each pension plan interprets these assumptions will greatly affect how much each plan's liability changes.

Although governments often skip out on their pension contributions, “plan sponsors can easily assert that adequate contributions will be made and, therefore, assets will always be available to cover projected benefits,” the report, released June 5, said. If this is the case, the new rules say the relevant discount rate reverts to the plan’s expected long-run rate of return (which is between 7.5 percent and 8 percent in most cases).

The new rules will also require plans to report the market value of their assets (based on the prior year’s investment return) instead of smoothing out the value over a period of years and using the average rate of return over that period. Up until this year, most plans’ smoothing periods have still included the losses of 2008 and 2009, resulting in reporting a lower investment return. Since 2009, many plans have posted double-digit returns on their investment. This means that plans’ actual values have been slightly higher than has been reported and that will be rectified starting in 2014.

Therefore, the report concludes, that overall liabilities of the roughly 150 plans included in its survey will remain at 72 percent in 2014.

But scary investment fees can endanger pensions

A new Pew Charitable Trusts study took a look at the increasing investment by pension funds in higher-risk assets like hedge funds and real estate. Written with the Arnold Foundation, the study warned that the shift in investment strategy has also meant higher fees paid to fund managers. During the 1980s and 1990s, plans significantly increased their reliance on stocks, also known as equities. And during the past decade, funds have turned to alternative investments such as private equity, hedge funds, real estate and commodities to achieve their target investment returns. Since 2006, the share of alternative investments in public plans’ portfolios have doubled to comprise nearly one-quarter of the average plan’s investment mix.

“These trends underscore the need for additional public information on plan performance, insight on best practices in fund governance, and attention to the effect of investment fees on plan health,” the study said. “With $3 trillion in assets and the retirement security of 14.5 million state and local employees at stake, sound investment strategy is critical.”

In short, increased investments in equities and alternatives could result in greater financial returns but also increased unpredictability and the possibility of losses on these assets, the study warns. Even a relatively small difference in return like 1 percent resulting from investment performance or fees equates to tens of million dollars in a multi-billion-dollar pension fund. Relying too heavily on these kinds of volatile investments could create massive instability in a fund that is supposed to provide retirement security for its members.

Busting up Puerto Rico’s budget

Just one month ago, Puerto Rico Gov. Alejandro García Padilla was touting a balanced budget for 2015 – the commonwealth’s first in more than a decade and coming one year earlier than the administration had projected. Now it looks as if that celebration was a little premature. Puerto Rico announced a $442 million revenue shortfall in April ($380 million because of corporate tax underpayments) and Municipal Market Advisors’ bi-weekly market brief said that’s making investors worried about the island’s near‐term liquidity, the FY 2015 budget and further borrowing plans.

The commonwealth has said that emergency cuts can get the government back on track (almost) to close out the fiscal year at the end of this month. But, notes MMA, a recent analysis by Sergio Marxuach, director of Public Policy at the Center for New Economy, showed that PR may carry a structural budget gap forward into FY 2015 as large as $1 billion.

“While the Governor has declared the budget ‘balanced,’ MMA’s view is that this balance is illusory given the island’s aggressive revenue estimates (up over $650M resulting from new revenue measures), continued reliance on a handful of corporations, over $500M of non‐recurring revenues, speculative proposed budget cuts, questionable savings, and lastly, the effect of the budget on the general economy,” the brief said.